Electronic FX trading gathers steam in 2014

While other leading markets are yet to follow Switzerland’s lead and mandate automated trading of currency, the industry moves inexorably towards automation. But the push creates new market risks for both the buy side and sell side.

"Spot FX is an example of a product that is well-suited to
being traded electronically," he says. "
Voice trading will never disappear entirely. It will
be used for more complicated instruments with specific maturity
dates and product features."

Aite Group research indicates that in 2013 electronic trading
accounted for two-thirds (66%) of the spot FX market activity
and by 2019 that figure is expected to increase to 72%. In
contrast, electronic FX options trading was at 38% last year
and, even allowing for centralized clearing, the firm
doesn’t expect that figure to be higher than 49%
by 2019.

Kieran Fitzpatrick, CEO at Barracuda FX, is convinced that
recent fixing scandals will encourage further use of
automated processes.

"We are already
seeing banks turn to automation to remove some of the human
element from the fixing process, driven by the regulatory
requirement to adhere to the recent Financial Stability Board
guidelines as well as a desire to manage their market
reputation," he says.

Ticket sizes continue to increase as clients become more
used to automated trading and tight bid/offer spreads encourage
banks to push their electronic offerings.

While many processes outside the core trading activity
remain manual, for example the on-boarding of a client into an
electronic multi-dealer platform, these administrative
processes are now also being addressed through initiatives such
as TESI (trading enablement standardization initiative).

"As well as the obvious reason of demand for greater
transparency from regulators, electronic trading also provides
greater control for banks to set and enforce trading and
pricing policies through their systems," he says.

Danesh warns that while algorithmic trading allows the buy
side to achieve better pricing, it also increases market
risk.

He adds: "By working a large order themselves, rather than
delegating the function to banks, the buy side will need to be
capable of managing greater risk even during periods of market
stress. This is a challenge for some, as their risk-management
systems are typically less mature compared to banks."

If you were being cynical you would say this
is
part of the motivation – further
consolidation and monopolization within the global
banking industry

Jasper Lawler

CMC Markets analyst Jasper Lawler says banks have encouraged
the trend towards further use of automated processes by owning
their own proprietary trading companies that develop
algorithms.

"Equally, high-frequency trading clients place a lot of
their trades by their very nature so can be very lucrative for
a bank that is making the market, although additional
algorithms are needed to manage order flow," he says.

Lawler suggests the cost of automation infrastructure
limits the number of institutions that can participate in the
market, thus reducing competition.

"If you were being cynical you would say this is part of the
motivation – further consolidation and monopolization
within the global banking industry," he says. "Automation
brings with it high initial costs, which will only be recovered
with increased efficiencies over time.

"The largest banks have the capital to invest and now is
arguably one of the best opportunities for them to do so when
expectations are so low for profitability in the industry
because of increased regulation."

Market risk

Etrading's Danesh accepts that the latency race has eased
somewhat as most participants have moved to a collocated
infrastructure and as FX venues adopt measures such as
randomized pauses. However, he says there are still
substantial benefits to having scale in this market
– especially when it requires handling market
risk.

One of the hypotheses that has been doing the rounds during
the past 12 months is that clients will gravitate away from the
large banks, but this has not happened, according to George
Kuznetsov, head of research and analytics at
Coalition.

"However, I would expect banks that are reliant on
institutional client activity to be in a challenging position,
which may lead to consolidation," he says.

Aite Group's Tai says this greater use of technology offers
some advantages to larger institutions that can implement
solutions more quickly, while smaller rivals might find it hard
to generate the volumes necessary to offset additional
infrastructure costs.

"However, white-labelling of third-party technology or even
single-bank dealer platforms is becoming common practice, which
means that smaller players with limited budgets can have an
electronic platform," he concludes.

Further reading on Euromoney

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